Australia: Creditors’ Trusts – Administrators Beware

Creditors' trusts are becoming more common in their use as
companies seek to quickly distance themselves from the voluntary
administration process and continue on with their corporate lives.
This is often for legitimate reasons, the most common being for
publicly listed companies seeking to minimise the impact of
voluntary administration on their listed status.

A creditors' trust in its simplest form sees the creditors
of a company forego their rights as creditors against that company
and in return become beneficiaries under a trust to share in a
"trust fund" that is established for this specific
purpose. The Administrator usually becomes the trustee of the trust
and has the main job of realising the trust fund and distributing
it to the beneficiaries.

1. Creditor's Trusts And Deeds Of Company Arrangement

Ordinarily, a creditors' trust is implemented as part of a
deed of company arrangement (DoCA) with the practical effect that
the DoCA is entered and then, shortly after, terminated and
replaced with the creditors' trust. The big advantage of this
strategy is that once the DoCA is terminated, the company is no
longer subject to any form of external administration and the
claims of its previous creditors are gone.

To get off the ground, the strategy has to be approved by
creditors at the major meeting held during the voluntary
administration process. Where the creditors' trust route
provides the best return for creditors, it is not uncommon for
creditors to vote in favour of the proposal.

Practitioners have different views on when it is and is not
appropriate to use creditors' trusts. ASIC has given some
guidance on this by issuing Regulatory Guide 82, which specifically
deals with creditors' trusts and their use.

2. Problems With The Use Of Creditor's Trusts

One of the major issues with creditor's trusts is
that creditors effectively lose the protections and rights
contained in the Corporations Act, which they would have
retained under a DoCA. This includes the ability to object and
appeal the Administrator's decision on the value of the
creditor's claim, the ability for the court to terminate the
DoCA and the court's overriding ability to supervise the
process.

Under a creditor's trust, the Corporations Act has
little operation and creditors are largely limited to the rights
actually contained in the trust deed and the general law.

In the recent case of Parkview Constructions Pty
Limited [2009] NSWSC 186, the Court was critical of the
situation that resulted from the implementation of a creditors'
trust. In that case, Parkview, a creditor applied to set aside the
DoCA of Sydney Civil Excavation Pty Limited (Sydney Civil) on a
variety of grounds.

The Court ultimately found that it was unable to assist Parkview
given the DoCA had already been terminated and replaced with the
creditors' trust. It was clear from the judgment that the Judge
had considerable unease that the creditors' trust had prevented
Parkview from obtaining any relief from the Court. The Judge
considered it a matter of concern that the "protective
aspects of Pt 5.3A...can be avoided by the creation through a deed
of company arrangement of a parallel but essentially unregulated
regime of administration."

The Court further provided a clear warning to Administrators
about their disclosure obligations when recommending a DoCA that
will lead to a creditors' trust. In such circumstances,
Administrators "bear a heavy burden of explaining to
creditors the implications of the shift from a regime incorporating
a court administered scheme of creditor protection to one in which
creditors become passive trust beneficiaries."

3. Implications

This case provides a timely reminder to Administrators about the
use of creditors' trusts. Specifically, practitioners should
take note of the Court's comments when preparing reports to
creditors about any proposal that includes a creditors' trust.
To avoid any uncertainty it may be better to approach the Court for
approval to execute the proposed creditors' trust, although the
delay in seeking that approval may defeat what is trying to be
achieved by the creditors' trust in the first place.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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Directors will need to carefully demonstrate compliance with the new obligations to gain benefit of the safe harbour.

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